Tax Crimes and the Sentencing Guidelines: Can Unclaimed Tax Deductions Be Considered in Calculating the “Tax Loss”?
The Ninth Circuit Court of Appeals recently affirmed the sentence handed down following a defendant’s conviction on two counts of tax evasion in violation of 26 U.S.C. § 7201. On appeal, the defendant argued that the lower court erred by not crediting unclaimed business expenses incurred by his company, DLSS, in calculating the applicable tax loss under the U.S. Sentencing Guidelines. The appellate court’s answer: “Not so.”
U.S. Sentencing Guidelines Manual § 2T1.1 generally governs the guideline calculations for tax evasion sentencings. The “tax loss” figure plays a central role in the overall recommended sentencing range under the Guidelines, often largely driving the overall Guideline range.
Under the guideline provisions, a sentencing court can consider a defendant’s unclaimed tax deductions in estimating the tax loss for sentencing purposes; however, the defense must demonstrate that the deductions are, among other things, “reasonably and practicably ascertainable.” U.S.S.G. § 2T1.1 cmt. n.3. Notably, the defendant bears the burden of providing any unclaimed deductions, and must establish the right to the deductions by a preponderance of the evidence. Id.
The Ninth Circuit, in United States v. Saifan, recently grappled with this issue. Here is an excerpt from the appellate court’s analysis of the defendant’s claims on this score:
Although Saifan plausibly argues that DLSS incurred some legitimate business expenses in the course of its performance on numerous contracts, he provided no invoices, bank statements, or any other documentation establishing what those expenses actually were. Nor does he point to a reliable method for the district court to reasonably approximate those expenses—an especially onerous task given that DLSS operated as a cash business in wartime Iraq. Accordingly, the district court did not err in finding that DLSS’s unclaimed business expenses were not “reasonably and practicably ascertainable,” and therefore excluding them from its tax loss calculation.
As the court’s analysis demonstrates, a defendant bears the burden—again, by a preponderance of the evidence—to establish that he is entitled to any unclaimed tax deductions. Merely showing that it is likely that the business incurred some expenses is not enough. Astute defense counsel will often need to engage in a studied, forensic analysis of the business’s operations and the underlying documentation in order to put together a convincing argument and demonstrate that a defendant is entitled to unclaimed tax deductions in order to lower the overall tax loss (and thus the resulting sentencing range under the Guidelines). The difficulties with this undertaking are often exacerbated where the taxpayer operated a cash business and did not maintain adequate records. However, given the impact that the tax loss figure can have on a defendant’s Guideline calculation, the effort is an important one and can often have a significant impact on a tax defendant’s Guideline sentencing range.
For the reader’s reference, the relevant Sentencing Guideline provision is set forth below:
(a) Base Offense Level:
(1) Level from §2T4.1 (Tax Table) corresponding to the tax loss; or
(2) 6, if there is no tax loss.
(b) Specific Offense Characteristics
(1) If the defendant failed to report or to correctly identify the source of income exceeding $10,000 in any year from criminal activity, increase by 2 levels. If the resulting offense level is less than level 12, increase to level 12.
(2) If the offense involved sophisticated means, increase by 2 levels. If the resulting offense level is less than level 12, increase to level 12.
(c) Special Instructions
For the purposes of this guideline—
(1) If the offense involved tax evasion or a fraudulent or false return, statement, or other document, the tax loss is the total amount of loss that was the object of the offense (i.e., the loss that would have resulted had the offense been successfully completed).
(A) If the offense involved filing a tax return in which gross income was underreported, the tax loss shall be treated as equal to 28% of the unreported gross income (34% if the taxpayer is a corporation) plus 100% of any false credits claimed against tax, unless a more accurate determination of the tax loss can be made.
(B) If the offense involved improperly claiming a deduction or an exemption, the tax loss shall be treated as equal to 28% of the amount of the improperly claimed deduction or exemption (34% if the taxpayer is a corporation) plus 100% of any false credits claimed against tax, unless a more accurate determination of the tax loss can be made.
(C) If the offense involved improperly claiming a deduction to provide a basis for tax evasion in the future, the tax loss shall be treated as equal to 28% of the amount of the improperly claimed deduction (34% if the taxpayer is a corporation) plus 100% of any false credits claimed against tax, unless a more accurate determination of the tax loss can be made.
(D) If the offense involved (i) conduct described in subdivision (A), (B), or (C) of these Notes; and (ii) both individual and corporate tax returns, the tax loss is the aggregate tax loss from the offenses added together.
(2) If the offense involved failure to file a tax return, the tax loss is the amount of tax that the taxpayer owed and did not pay.
(A) If the offense involved failure to file a tax return, the tax loss shall be treated as equal to 20% of the gross income (25% if the taxpayer is a corporation) less any tax withheld or otherwise paid, unless a more accurate determination of the tax loss can be made.
(B) If the offense involved (i) conduct described in subdivision (A) of these Notes; and (ii) both individual and corporate tax returns, the tax loss is the aggregate tax loss from the offenses added together.
(3) If the offense involved willful failure to pay tax, the tax loss is the amount of tax that the taxpayer owed and did not pay.
(4) If the offense involved improperly claiming a refund to which the claimant was not entitled, the tax loss is the amount of the claimed refund to which the claimant was not entitled.
(5) The tax loss is not reduced by any payment of the tax subsequent to the commission of the offense.
Statutory Provisions: 26 U.S.C. §§ 7201, 7203 (other than a violation based upon 26 U.S.C. § 6050I), 7206 (other than a violation based upon 26 U.S.C. § 6050I or § 7206(2)), and 7207. For additional statutory provision(s), see Appendix A (Statutory Index).
1. Tax Loss.—“Tax loss” is defined in subsection (c). The tax loss does not include interest or penalties, except in willful evasion of payment cases under 26 U.S.C. § 7201 and willful failure to pay cases under 26 U.S.C. § 7203. Although the definition of tax loss corresponds to what is commonly called the “criminal figures,” its amount is to be determined by the same rules applicable in determining any other sentencing factor. In some instances, such as when indirect methods of proof are used, the amount of the tax loss may be uncertain; the guidelines contemplate that the court will simply make a reasonable estimate based on the available facts.
Notes under subsections (c)(1) and (c)(2) address certain situations in income tax cases in which the tax loss may not be reasonably ascertainable. In these situations, the “presumptions” set forth are to be used unless the government or defense provides sufficient information for a more accurate assessment of the tax loss. In cases involving other types of taxes, the presumptions in the notes under subsections (c)(1) and (c)(2) do not apply.
Example 1: A defendant files a tax return reporting income of $40,000 when his income was actually $90,000. Under Note (A) to subsection (c)(1), the tax loss is treated as $14,000 ($90,000 of actual gross income minus $40,000 of reported gross income = $50,000 x 28%) unless sufficient information is available to make a more accurate assessment of the tax loss.
Example 2: A defendant files a tax return reporting income of $60,000 when his income was actually $130,000. In addition, the defendant claims $10,000 in false tax credits. Under Note (A) to subsection (c)(1), the tax loss is treated as $29,600 ($130,000 of actual gross income minus $60,000 of reported gross income = $70,000 x 28% = $19,600, plus $10,000 of false tax credits) unless sufficient information is available to make a more accurate assessment of the tax loss.
Example 3: A defendant fails to file a tax return for a year in which his salary was $24,000, and $2,600 in income tax was withheld by his employer. Under the note to subsection (c)(2), the tax loss is treated as $2,200 ($24,000 of gross income x 20% = $4,800, minus $2,600 of tax withheld) unless sufficient information is available to make a more accurate assessment of the tax loss.
In determining the tax loss attributable to the offense, the court should use as many methods set forth in subsection (c) and this commentary as are necessary given the circumstances of the particular case. If none of the methods of determining the tax loss set forth fit the circumstances of the particular case, the court should use any method of determining the tax loss that appears appropriate to reasonably calculate the loss that would have resulted had the offense been successfully completed.
2. Total Tax Loss Attributable to the Offense.—In determining the total tax loss attributable to the offense (see§1B1.3(a)(2)), all conduct violating the tax laws should be considered as part of the same course of conduct or common scheme or plan unless the evidence demonstrates that the conduct is clearly unrelated. The following examples are illustrative of conduct that is part of the same course of conduct or common scheme or plan: (A) there is a continuing pattern of violations of the tax laws by the defendant; (B) the defendant uses a consistent method to evade or camouflage income, e.g., backdating documents or using off-shore accounts; (C) the violations involve the same or a related series of transactions; (D) the violation in each instance involves a false or inflated claim of a similar deduction or credit; and (E) the violation in each instance involves a failure to report or an understatement of a specific source of income, e.g., interest from savings accounts or income from a particular business activity. These examples are not intended to be exhaustive.
3. Unclaimed Credits, Deductions, and Exemptions.—In determining the tax loss, the court should account for the standard deduction and personal and dependent exemptions to which the defendant was entitled. In addition, the court should account for any unclaimed credit, deduction, or exemption that is needed to ensure a reasonable estimate of the tax loss, but only to the extent that (A) the credit, deduction, or exemption was related to the tax offense and could have been claimed at the time the tax offense was committed; (B) the credit, deduction, or exemption is reasonably and practicably ascertainable; and (C) the defendant presents information to support the credit, deduction, or exemption sufficiently in advance of sentencing to provide an adequate opportunity to evaluate whether it has sufficient indicia of reliability to support its probable accuracy (see §6A1.3 (Resolution of Disputed Factors) (Policy Statement)).
However, the court shall not account for payments to third parties made in a manner that encouraged or facilitated a separate violation of law (e.g., “under the table” payments to employees or expenses incurred to obstruct justice).
The burden is on the defendant to establish any such credit, deduction, or exemption by a preponderance of the evidence. See §6A1.3, comment.
4. Application of Subsection (b)(1) (Criminal Activity).—“Criminal activity” means any conduct constituting a criminal offense under federal, state, local, or foreign law.
5. Application of Subsection (b)(2) (Sophisticated Means).—For purposes of subsection (b)(2), “sophisticated means” means especially complex or especially intricate offense conduct pertaining to the execution or concealment of an offense. Conduct such as hiding assets or transactions, or both, through the use of fictitious entities, corporate shells, or offshore financial accounts ordinarily indicates sophisticated means.
6. Other Definitions.—For purposes of this section:
A “credit claimed against tax” is an item that reduces the amount of tax directly. In contrast, a “deduction” is an item that reduces the amount of taxable income.
“Gross income” has the same meaning as it has in 26 U.S.C. § 61 and 26 C.F.R. § 1.61.
7. Aggregation of Individual and Corporate Tax Loss.—If the offense involved both individual and corporate tax returns, the tax loss is the aggregate tax loss from the individual tax offense and the corporate tax offense added together. Accordingly, in a case in which a defendant fails to report income derived from a corporation on both the defendant’s individual tax return and the defendant’s corporate tax return, the tax loss is the sum of (A) the unreported or diverted amount multiplied by (i) 28%; or (ii) the tax rate for the individual tax offense, if sufficient information is available to make a more accurate assessment of that tax rate; and (B) the unreported or diverted amount multiplied by (i) 34%; or (ii) the tax rate for the corporate tax offense, if sufficient information is available to make a more accurate assessment of that tax rate. For example, the defendant, the sole owner of a Subchapter C corporation, fraudulently understates the corporation’s income in the amount of $100,000 on the corporation’s tax return, diverts the funds to the defendant’s own use, and does not report these funds on the defendant’s individual tax return. For purposes of this example, assume the use of 34% with respect to the corporate tax loss and the use of 28% with respect to the individual tax loss. The tax loss attributable to the defendant’s corporate tax return is $34,000 ($100,000 multiplied by 34%). The tax loss attributable to the defendant’s individual tax return is $28,000 ($100,000 multiplied by 28%). The tax loss for the offenses are added together to equal $62,000 ($34,000 + $28,000).
Background: This guideline relies most heavily on the amount of loss that was the object of the offense. Tax offenses, in and of themselves, are serious offenses; however, a greater tax loss is obviously more harmful to the treasury and more serious than a smaller one with otherwise similar characteristics. Furthermore, as the potential benefit from the offense increases, the sanction necessary to deter also increases.
Under pre-guidelines practice, roughly half of all tax evaders were sentenced to probation without imprisonment, while the other half received sentences that required them to serve an average prison term of twelve months. This guideline is intended to reduce disparity in sentencing for tax offenses and to somewhat increase average sentence length. As a result, the number of purely probationary sentences will be reduced. The Commission believes that any additional costs of imprisonment that may be incurred as a result of the increase in the average term of imprisonment for tax offenses are inconsequential in relation to the potential increase in revenue. According to estimates current at the time this guideline was originally developed (1987), income taxes are underpaid by approximately $90 billion annually. Guideline sentences should result in small increases in the average length of imprisonment for most tax cases that involve less than $100,000 in tax loss. The increase is expected to be somewhat larger for cases involving more taxes.
Failure to report criminally derived income is included as a factor for deterrence purposes. Criminally derived income is generally difficult to establish, so that the tax loss in such cases will tend to be substantially understated. An enhancement for offenders who violate the tax laws as part of a pattern of criminal activity from which they derive a substantial portion of their income also serves to implement the mandate of 28 U.S.C. § 994(i)(2).
Although tax offenses always involve some planning, unusually sophisticated efforts to conceal the offense decrease the likelihood of detection and therefore warrant an additional sanction for deterrence purposes.
The guideline does not make a distinction for an employee who prepares fraudulent returns on behalf of his employer. The adjustments in Chapter Three, Part B (Role in the Offense) should be used to make appropriate distinctions.
|Historical Note||Effective November 1, 1987. Amended effective November 1, 1989 (amendments 219–223); November 1, 1990 (amendment 343); November 1, 1992 (amendment 468); November 1, 1993 (amendment 491); November 1, 1998 (amendment 577); November 1, 2001 (amendment 617); November 1, 2002 (amendment 646); November 1, 2013 (amendment 774).|
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